Never Mind the 1 Percent. Let’s Talk About the 0.01 Percent

This income is broad-based among the 1 percent. “What’s covered on CNBC or in the Wall Street Journal or New York Times might be overemphasizing the drivers of wealth in Wall Street and Silicon Valley, and the economy is much bigger and more diverse than that,” Zwick says. “There are a few Carnegies and Rockefellers, a Bill Gates and a Jeff Bezos here and there, but there are a lot more people earning between $300,000 and a few million dollars doing a lot of different things.”

Smith, Yagan, Zidar, and Zwick find that the 1 percent’s income is being driven by owner-managers, mostly of small and medium-sized companies—specifically S corporations, partnerships, and limited liability companies. These are talented managers: the researchers find that profits of companies run by these 1 percent-ers are far higher than those of businesses owned by people in the top 5-–10 percent. In the researchers’ sample, when these businesses’ owners died prematurely, while still running their companies, profits plunged by more than half.

The average company in the top 1 percent of income has $7 million in sales and 57 employees, according to the research. “If that firm has, say, a 10 percent profit margin to split between two owners, it’s enough to put someone in the top 1 percent category,” says Zwick. The businesses earning the most profits in the bulk of the top 1 percent were physicians’ and dentists’ offices, professional and technical services, specialty trade contractors, and legal services.

To reach the top 0.1 percent of income, the average company has $30 million in sales and 150 employees. “If you’re an auto dealer and you have five or six dealerships and you’re doing $30 million in sales, you have a bunch of workers and you split $3 million in profits between one or two owners, that would put you in that top 0.1 percent group,” says Zwick. In the top 0.1 percent, physicians’ offices ranked only sixth in profits—behind managements of private companies, financial and investment activities, auto dealers, professional and technical services, and oil and gas extraction.

It’s harder to get at the source of income for the top 0.01 percent, but several studies indicate that finance could be an important sector for the group. Williams College’s Jon Bakija, the US Treasury Department’s Adam Cole, and Indiana University’s Bradley T. Heim find that one-fifth of the primary taxpayers in the top 0.1 percent of income (including capital gains) work in finance. The latest data used in this study are from 2005, before the 2007–10 financial crisis altered the landscape. But between 2008 and 2012, “finance and insurance is by far the most highly represented industry among the highest earners,” find Guvenen and Kaplan, who looked at the 0.1 percent. In the rest of the 1 percent, health care is the most represented sector.

Beyond that, there’s more detailed information about only the very richest of the 0.01 percent, and it seems to suggest that the richest members of the group may own large, successful businesses. Kaplan and Stanford’s Joshua Rauh used Forbes’ “rich list” as a data set on the wealth of the richest Americans. Since 1982, Forbes has compiled an annual list of the 400 wealthiest Americans, using public information, private interviews, and valuations of comparable assets. As the rich list comprised 400 households, it represents the top 2.5 percent of the 0.01 percent—the top 0.00025 percent of US households.

But this small group could control more than a quarter of the income in the 0.01 percent. According to Saez and Zucman’s calculations, in 2012 the top 0.01 percent had an average wealth of $371 million, which would imply a collective total of $6 trillion. That same year, the estimated combined net worth of the individuals on the Forbes 400 list was $1.7 trillion.

Among the group who made the rich list, for almost one in four, finance—especially hedge funds and private equity—was the source of wealth, while 15 percent came from technology-based companies. Food and beverage companies accounted for 10 percent.

And these sectors were on the upswing. “The ‘finance and investments’ category grew in representation by around 16 percentage points, technology (both computer and medical) by 11 percentage points, and retail/restaurant by 10 percentage points,” Kaplan and Rauh write.

On the 2016 rich list, two-thirds were self-made and one-third had inherited at least part of their fortune. More than 10 percent were immigrants to the US.

How did they get so wealthy?

Piketty and Saez have theorized that investments grow faster than the economy, giving entrenched dynasties insuperable advantages. But Kaplan and Rauh argue that the super-rich are predominantly creating rather than inheriting wealth. Kaplan also says that wealth in this group has been fueled by a marriage of in-demand skills, globalization, and technology—the combination of which are allowing businesses to scale up as never before.

Skills, say many economists, are critical to the modern economy. As the US economy grows, jobs are going unfilled as companies scramble to find skilled people to hire. There’s a flip side to this: as certain skills have become scarce, this has raised the amount companies are willing to pay people who have them. The situation has similarly raised the amount of profits skilled company owners can make, and technology and globalization are further magnifying the value of in-demand skills.

If this is true, the 0.01 percent are most likely benefiting from what economists call “skill-biased technological change”—the increasing return on certain skills in an economy driven by technology and globalization. Under this well-established theory, a shortage of in-demand skills raises the value of those skills in rapidly expanding markets, and new technology helps some workers’ productivity grow much more than others’, exacerbating inequality.

In the Information Age, the change has been particularly pronounced. “In business, you can use technology to do things you couldn’t do 30 years ago,” says Steve Kaplan. “You can scale your business using technology, and you can use people in India and China and all over the world—you couldn’t do that as effectively 30 years ago.” This, he argues, has been spectacularly positive for poorer people in developing countries. In 1990, the World Bank estimated that roughly 35 percent of the world lived in extreme poverty. Today, less than 11 percent of the world’s population is so impoverished.

And it has been good for wealthy residents of developed countries. For them, the result has taken the form of the “superstar” or “winner-take-all” phenomenon, first identified in a landmark 1981 paper by the late Sherwin Rosen, who taught at the University of Chicago. “In certain kinds of economic activity there is concentration of output among a few individuals,” wrote Rosen. “Relatively small numbers of people earn enormous amounts of money and dominate the activities in which they engage.”

Technology, from the internet to media such as ESPN and Bloomberg terminals, has given elite athletes, entertainers, entrepreneurs, and financiers the ability to profit on a much larger, global scale, making the fruits of their labor more valuable than what previous superstars, such as, say, Pelé or Babe Ruth, brought in. Ruth’s peak salary of $80,000 would be worth about $1.1 million in 2016 dollars, around one-thirtieth of the $33 million the highest-paid Major League Baseball player, pitcher Clayton Kershaw of the Los Angeles Dodgers, made in salary alone in 2016.

The world’s hundred highest-paid athletes, led by Cristiano Ronaldo and LeBron James, stars of soccer and basketball, respectively, “banked a cumulative $3.11 billion” over the past 12 months, Forbes calculated this past June. Among entertainers, rapper/entrepreneur Diddy and singer Beyoncé each raked in more than $100 million over the same period, Forbes estimated.

And hedge-fund managers make multiples more than top athletes and entertainers. James Simons of Renaissance Technologies and Ray Dalio of Bridgewater Associates each made more than $1 billion in 2016, even though, as Institutional Investor’s Alpha reported, the top-25 hedge-fund earners took in the least as a group since 2005, largely because of the industry’s overall poor investment performance.

“Technology allows a hedge fund to be able to manage $20 billion and invest it,” says Steve Kaplan. “I don’t think people had the systems and information to do that 20 to 30 years ago. Now they have the systems and the information to do that. That technological change is here and is not going away. If anything, it’s getting stronger.”

What should policy makers do (if anything)?

The question of what, if anything, should be done in response to the spectacular rise of the 0.01 percent is a thorny one, as Mankiw acknowledged. “At the outset, it is worth noting that addressing the issue of rising inequality necessarily involves not just economics but a healthy dose of political philosophy,” he wrote.

When policy makers want to address the concentration of income and wealth, the first place some have looked is the top marginal tax rate, which slid in the US and other developed countries after the Reagan and Thatcher revolutions. The US and UK had tax rates as high as 80 percent, wrote Saez and Piketty in the Guardian in 2013. “The job of economists should be to make a top rate tax level of 80 percent at least ‘thinkable’ again.” But on this, Steve Kaplan disagrees. Raising the top marginal rate could send people and their money scurrying for tax havens, he says, pointing to France as an example.

Raising the top tax rates in the US could also send people to take advantage of more favorable tax rules within the code itself. And closing perceived loopholes can be controversial. For example, some people working in finance benefit from the code’s treatment of carried interest, where income flowing to the general partner of an investment fund is typically treated as capital gains and therefore taxed at a lower rate.